By: Robyn Klingler
As the leaders of the top 20 industrialized countries pour to London to attend the G20 summit, Billionaire George Soros is also in town, promoting his new book at the London School of Economics (LSE). The book is titled The Credit Crisis of 2008 and What It Means. The central gist of the book and his talk at the LSE is that the International Monetary Fund (IMF) reallocate the funds available for Special Drawing Rights (SDRs). Special Drawing Rights are IMF funds available as very low interest rate loans (currently 0.01%) convertible into five different currencies. In London this week he is advocating that the G20 (meeting on April 1st) initiates this reallocation of SDRs such that more is given to poor countries. By poor countries Mr. Soros means least developed countries and/or those countries unable to bail out their financial system.
Soros explained that the current crisis is ‘the financial crisis of our lifetime’ and that it is different from all other crises because it was created by the financial system itself.’ The paradigm that we have been operating under, that markets are self-correcting, has been undermined, if not demolished since the crisis began in the markets and then spread to the real economy (the crisis did not come from exogenous shocks, it came from within). Soros offers a new paradigm, in which we believe that markets always distort reality, rather than reflect its fundamentals and one that acknowledges that markets actually shape reality. George explained that the markets are good at predicting the future because they are actually shaping the future.
The bigger the bubble, the bigger the bust
There was a twinge of Keynesian fear of ‘hot money’ and markets as Soros lamented that bubbles and crashes are natural features of markets. Read: markets will always cause bubbles and crashes, its just part of the game. He argued that there are two types of bubbles. The first is the ‘simple bubble’ which is driven by the underlying misconception that asset prices are not aligned with the willingness to lend. Rather, asset prices and the willingness to lend are intricately related. The second and more scaring bubble, the ‘super bubble’ is caused by the belief that markets are self-correcting and therefore do not need to be regulated.
He contends that previous crises were quelled because of intervention to control the fall out. This time, globalization, deregulation, and financial engineering reinforced the underlying misconceptions for so long that the states did not intervene (he mentioned Lehman Brothers’ demise and the fact that he did not foresee such an event). That week in September Soros believes the system suffered a cardiac arrest, and was subsequently put on life support – as no more systemically important institutions were allowed to fail.
Suffering in the periphery
Mr. Soros discussed the flight of capital from the periphery (emerging markets) to the center (OECD) following the meltdown, specifically the Icelandic crisis. Now, he quipped, the situation at the centre is under control, but the situation in the periphery is still a crisis. The G20 this week needs to stabilize the position of the periphery countries by at least doubling IMF funds during the summit, and reallocating SDRs. He notes that the increase in IMF funding will not provide a systemic solution, however he believes that it will be a tremendous help. George identified the United States, specifically President Obama, as the key actor in authorizing the increased SDR funds and reallocation. Historically America has been opposed to SDRs as it undermines the US dollar as the international reserve currency, but Soros thinks that the US can benefit from the backing of SDRs in the long-term. In fact, he supposes that the US support of an international currency is also in its favour (reminiscent again of Keynes’ suggestion of the global currency at Bretton Woods in the early 1940s).
In addition to the reallocation of IMF funds, Soros recommends that the G20 rollover the debt that emerging markets hold, as they did with South Korea during the Asian financial crisis in 1998. The proposed $200 to $250B in annual SDR contributions, while a great help, will not quell the rollover issue as outstanding debt currently stands at $1.4 trillion.
Soros’ answers to questions from the audience:
- Gold is not a very good currency base because it can’t keep up with growth and inflation as it has a fixed supply, so we will not see a return to a gold standard.
- There is currently a stigma attached to drawing upon SDRs, so countries refrain from borrowing; the IMF needs to change or play down its conditionality to reduce this stigma
- China’s life depends upon economic growth, social unrest would spread if its economy slowed, so China needs to play ball within the multi-lateral system to survive. However, China can also lend money to countries other than the US to maintain its export-led growth. He predicts that China will come out of the recession first.
- To fix the situation we need to: effectively print money, recapitalize the bank, and stabilize the housing market.
- The US dollar is strong now because there is a shortage of dollars in the world.
- Soros calls for greater regulation of the markets, as again, he laments that markets are inherently unstable and asset bubble will arise, so we need regulation to control (not prevent) bubbles. The envisioned regulation is an international one. However, the chair of the event, Howard Davies – current LSE Director and former FSA Chairman, notes that an international regulatory system will need to be both internationally consistent and nationally flexible to allow different applications across countries according to their situation.
- Someone asked how the markets will perform in 2009, to which Soros responded, “I know exactly what the markets will do in 2009, but I’m not at liberty to disclose it.”
For more information on the G20 summit in London: http://news.bbc.co.uk/2/hi/business/7970199.stm
[Robyn Klingler is an experienced financial services professional and is currently completing her MSc at the London School of Economics]